Economies and middle income trap: Ireland among few escapees

The term “middle income trap” was coined in 2007 by two World Bank economists and while emerging and other developing economies may stop growing or go into reverse for various reasons, the slowing of China and the end of a decade long commodity boom has been the main factor in the current travails of emerging and developing economies in particular. Since 1960, Ireland has been among the few economies that succeeded in moving from middle income to high income.

The recent spike in commodity prices undid the decline of the previous century, with prices rising to levels not seen since the early 1900s. The world grew accustomed to relatively low international food prices in the 1980s and the 1990s, when prices adjusted for inflation were below those recorded during the Great Depression, according to the International Monetary Fund (IMF).

In 2014 in a paper, World Bank economists reported on research on whether the so-called trap exists. Low income countries were defined as those with per capita incomes less than 10% of the US; middle income countries as those with per capita incomes between 10% and 50% of the US; and high income countries as those with per capita incomes over 50% of the US — here they divided middle income countries into lower and upper middle income countries using a threshold of 30% of the US.

The economists concluded that there isn't an inevitable trap:

countries that grow fast continue to grow fast, and they do not get “stuck” at any particular middle income level. This suggests that becoming “trapped” in some middle income level is not inevitable. However, this finding does not mean that there are no countries that are trapped at a middle income level. Indeed, middle income countries that did not “escape” remain stagnant with low growth at all levels of relative income. Relative income levels are highly persistent, and transitioning from middle income to high income is hard.

The evidence shows that very few countries move from middle income to high income.

In Latin America and the Middle East for example, most economies reached middle income status as early as the 1960s and 1970s and have remained there ever since (see chart below).

Puerto Rico like Ireland has benefited from being able to offer generous tax incentives to mainland US multinationals but restrictions in incentives and poor governance have triggered a serious economic crisis — the island’s population has fallen every year since 2005 and about 46.2% of Puerto Ricans live below the poverty line, compared with 14.8% in the US, Census Bureau data show.

Impact of emerging and developing economies

Christine Lagarde, IMF managing director, said in a speech last February that emerging and developing economies account for almost 60% of global GDP, up from just under half only a decade ago. They contributed more than 80% of global growth since the 2008 financial crisis, helping to save many jobs in advanced economies, too. And they have been the main driver behind the significant reduction in global poverty.

China alone has lifted more than 600m people out of poverty over the past three decades.

Lagarde said that after years of success, however, emerging markets — as a group — are now facing a new, harsh reality. Growth rates are down, capital flows have reversed, and medium-term prospects have deteriorated sharply. Last year, for example, emerging markets saw an estimated $531bn in net capital outflows, compared with $48bn in net inflows in 2014.

Between 1980 and 2007 global capital flows increased more than 25-fold, compared with an eight-fold expansion in global trade. Lagarde added:

The good news is that this has underpinned higher investment in many emerging economies that need foreign capital to finance their development. The bad news is that we have seen episodes of high capital flow volatility that can contribute to financial pressures in the emerging world and can — as I noted previously — “spillback” to the advanced economies.

There is now a growing recognition that the short-term nature and inherent volatility of global capital flows are problematic.